As MicroStrategy accumulates a large amount of Bitcoin, concerns begin to arise about whether its debt will force it to sell Bitcoin on the market, thus triggering a price spiral decline. Due to the complexity of the debt structure, this question likely does not have a simple 'yes' or 'no' answer.
Article Author: BitMEX Research
Source: BitMEX Research
MicroStrategy holds over 250,000 Bitcoins, and its stock price has a significant premium over its net asset value (NAV). This inevitably evokes memories of a similar high-premium phenomenon for the Grayscale Bitcoin Trust (GBTC) before its conversion to an ETF, which attracted a large influx of funds. However, we are puzzled as to why these two investment vehicles can trade at such high premiums and cannot provide a reasonable explanation. Even more confusing is that MicroStrategy has been able to issue a large amount of stock at a premium valuation to acquire more Bitcoins, thus driving up the book value per share. This seemingly 'infinite funding' cycle operation is perplexing. Since initiating its Bitcoin strategy, MicroStrategy has announced five rounds of equity issuance, raising a total of $4.4 billion.
MSTR Circulating Shares (Millions)
History seems to be repeating itself. MicroStrategy's owner Michael Saylor is viewed by many as a 'bad guy' in the Bitcoin space due to some controversial positions. These positions include his apparent hostility towards supporting Bitcoin developers, opposition to privacy technologies, and his brief but outspoken opposition to self-custody. Similarly, Mr. Barry Silbert, who controls Grayscale, has also been controversial for being a leading organizer of the 2017 'New York Agreement', which proposed a doomed proposal for the industry to abandon Bitcoin in favor of a flawed and buggy BTC1 client alternative called 'SegWit2x'.
As MicroStrategy accumulates a large amount of Bitcoin, with a market capitalization approaching $50 billion, concerns begin to arise. In particular, some ask whether MicroStrategy's debt will force it to sell Bitcoin on the market, thus triggering a price spiral decline. Unfortunately, due to the complexity of the debt structure, this question does not have a simple 'yes' or 'no' answer. Nevertheless, we have reviewed the relevant documents and will do our best to address this issue in this article.
Disclaimer
We would like to state: we are not bond traders, bond market experts, or lawyers, and this serves as a disclaimer for this article. The corporate debt market can be quite complex, and non-professionals may find it difficult to navigate. This article is likely to contain many errors. Furthermore, this article oversimplifies the products and does not comment on many conditions and complexities. Please do not rely on any information in this article, and if there are errors, please feel free to correct them.
MicroStrategy's bonds
As far as we know, MicroStrategy has issued seven rounds of publicly traded convertible bonds since announcing its Bitcoin strategy, as follows.
First, it should be noted that two of the bonds have been fully redeemed and are therefore not related to outstanding debt. Therefore, MicroStrategy has five outstanding bonds with a principal value of $4.25 billion. We will examine these five bonds.
Redemption and conversion options
The structure of the bonds is relatively complex, and as far as we know, there are four different types of conversion options available before maturity. The following figure summarizes these conversion options for the latest instrument (the bond maturing in 2028).
MicroStrategy 0.625% 2028 Bond Timeline:
Sorting through convertible bond options:
As far as we know, aside from the zero-coupon bond issued by MicroStrategy in September 2021, the mechanisms of the other four convertible bonds are basically the same, with only differences in price and date. Holders of zero-coupon bonds cannot redeem cash before maturity unless there is a 'fundamental change' in the business. This could be crucial if the Bitcoin price drops.
The table below lists the key dates associated with the cash conversion options of five bonds:
Source: Bond issuance documents
Note: *The stock must trade at a price more than 30% above the conversion price for at least 20 days within any 30-day rolling trading window.
MicroStrategy's conversion rights
It is important to note that for the zero-coupon bond, the cash option date for MicroStrategy in February 2024 has already passed. The conversion price is $143.25, and a 30% premium on that is $186.23. Currently, the MSTR stock price is $214, well above this price. However, in the past 30 trading days, it has only been above this price for 11 days. Therefore, this option is about to become effective, but it is not yet exercisable. Exercising this option would create value for MSTR shareholders, but bondholders are likely able to prevent this from happening by exercising their conversion rights.
These complex factors make bond valuation quite difficult, as convertible bonds have various potential outcomes. However, many creditors may be experienced professional bond investors who have models for performing these calculations.
Bond interest payments
Of the five outstanding bonds, four carry interest payments. These coupons represent cash liabilities, and theoretically, MicroStrategy could be forced to sell Bitcoin to fulfill payment obligations. However, given the relatively low interest rates and the fact that its traditional software business generates ample free cash flow to cover interest costs, even a crash in Bitcoin prices would not be enough to force the company to sell Bitcoin to pay bond interest. In summary, we believe the interest costs will not lead to MicroStrategy being forced to sell Bitcoin.
Conclusion
MicroStrategy's debt size is $4.25 billion, calculated based on its borrowed principal. Meanwhile, the company's stock currently has a market value of up to $43 billion, with its held Bitcoin valued at $17 billion. Thus, it can be seen that bonds do not account for a high proportion in MicroStrategy's capital structure.
However, if the Bitcoin price were to drop significantly, for example, to around $15,000 per coin, and if MicroStrategy could not take on more debt, analysts may need to consider the 'forced liquidation' of Bitcoin. However, this potential forced liquidation timing will focus on the maturity dates and option exercise dates mentioned in this article, which are spread between 2027 and 2031, and the timing is very specific. Therefore, even if Bitcoin does drop to around $15,000, we believe the likelihood of MicroStrategy being forced to sell Bitcoin to repay bonds remains low.
Although MicroStrategy is unlikely to be forced to sell Bitcoin, we believe a more likely scenario is that MicroStrategy will voluntarily sell Bitcoin to maximize shareholder value. Currently, MicroStrategy's stock price has a significant premium over its net asset value (NAV). Once this premium disappears or even turns into a discount (which is almost inevitable), and if the bonds are nearing maturity, selling Bitcoin to raise funds to repay debt will become the best option in the interest of shareholders. However, as long as the stock price maintains a premium, MicroStrategy can continue to leverage this for ongoing 'revolving credit' operations, and there would be no reason to sell Bitcoin. Of course, this state of a significant premium cannot last forever.
Additionally, it is important to note that if MicroStrategy's stock price can continue to maintain a premium and the market demand for MSTR bonds remains strong, the company may issue more debt. This would lead to an increase in its debt risk and raise the possibility of forced selling during a sharp drop in Bitcoin prices. However, for now, MicroStrategy's leverage is low, and the liquidation risk is also at a low level.
